On February 12 2017 the Swiss electorate voted against the federal Corporate Tax Reform III (CTR III). Despite a successful referendum, it was clear that maintaining the status quo could not be the solution. Instead, a revised version of the tax reform would have to be adopted, which would be palatable to all stakeholders and which would be both competitive and in line with international standards. Based on these principles, the Swiss federal government has in the meantime devised a revised tax reform proposal under the title 'Steuervorlage 17' (Swiss Tax Reform 17 or STR 17). The cornerstones of the new proposal were approved by the steering committee for the tax reform on June 1 2017 and confirmed by the Swiss federal government on January 31 2018 following the consultation process with all stakeholders, such as the political parties, the business community, the cantons and the trade unions in the autumn of last year. The proposal will be introduced to the Swiss Parliament by the spring of 2018.
Background of Swiss Tax Reform 17
The reform's first aim is to phase out all special corporate tax regimes. This request from the international tax community is undisputed and has the full support of the Swiss federal government and all the cantons as well as all political parties and the business community. The abolition of the holding, domiciliary, mixed company, principal company and finance branch regimes is at the centre of STR 17. A second goal is the alignment of the Swiss tax law with the international requirements of our time and to introduce internationally accepted standards for supporting holding, financing and research and development (R&D) activities, while maintaining the high competitiveness of Switzerland as a business location for multinationals and domestic companies alike. The third aim of the reform is to allow for a smooth transition into the new regime and to allow the Swiss cantons to reduce the cantonal tax rates gradually over time to levels that are very competitive internationally. This will ensure a continued reasonable competition among the cantons, which is the best guarantee for low tax rates and business friendly cantonal tax authorities.
Tax proposal 2017
Since the economic strength and tax revenue capacity of the individual cantons varies widely, the sole reduction of the cantonal tax rates to internationally competitive levels of approximately 12% to 14% for most cantons is not the only measure to sustain a competitive tax environment. Therefore, STR 17 provides various fiscal measures and either mandatory or optional taxation measures for cantons. The focus is on 'mobile' functions – meaning holding, finance and R&D functions. Table 1 summarises the replacement measures proposed under STR 17.
|Taxation measures||Federal||Cantons and communities|
|Holding functions||Already in place||Already in place|
|R&D functions – patent-box||No||Yes – mandatory|
|R&D functions – notional deduction on R&D expenditure||No||Yes – optional|
|Finance functions – notional interest deduction (NID)||No||N/A – optional|
|Step-up on migration into Switzerland||Yes||Yes – mandatory|
|Tax-privileged release of hidden reserves in cases of status change||N/A||Yes – mandatory|
|Reduction in capital tax on ‘mobile’ capital||N/A||Yes – optional|
|Tax rate reductions in cantons and an increase of the share of the cantons on income from direct federal taxes to 21.2% as financial assistance to the cantons.|
|Modification of the national financial equilibrium mechanism (NFA) – to make continued inter-cantonal tax competition financially bearable for all cantons.|
There are three restrictions on these tax measures to avoid so-called 'dynamic' tax losses and to secure continued adequate tax revenues:
- First, the relief of each measure is limited: the patent-box relief is limited to a maximum of 90% of the taxable income and the super deduction on R&D expenditure is limited to 150% of the expenditure;
- Second, the total tax reduction resulting from the tax measures cannot be higher than 70% of the total profit without deductions; and
- Third, on a cantonal level the requirement is to tax at least 70% of the minimal qualified dividend income for the investors.
Besides these limitations, the cantons have great flexibility to combine different measures with either a higher or lower tax rate reduction. The final 'measures mix' will therefore depend on the canton-specific facts, e.g. on whether a canton has weak or strong infrastructure, many or few companies with special tax regimes (such as mixed or holding company regimes) and high or low tax revenues in general.
Dividend income and capital gains from qualifying participations are already subject to an indirect participation exemption regime. The Swiss participation exemption regime will not be amended as part of STR 17, but extended to companies that benefit from a special tax regime. Both tax practitioners and tax scholars recognise a certain need to amend the existing participation exemption regime, but we do not expect STR 17 to propose any adjustments with regard to this regime.
There will be a change in regard to annual capital taxes, which are levied at the cantonal level, but not at the federal level. At the moment, companies with a holding or mixed company regime benefit from substantially reduced capital tax rates. In light of STR 17 it is envisaged to change to either a tax credit system (i.e. credit capital tax with income tax) or a participation exemption regime for capital taxes (i.e. equity related to participations would be exempt or benefit from a lower rate).
As far as the mobile R&D function is concerned, prevailing international practices offer two instruments – the 'patent box' and the 'R&D super deduction' or 'R&D tax credit'. Switzerland will introduce both a patent box and an R&D super deduction:
- A mandatory patent box following the modified nexus approach on a cantonal level with tax relief for qualifying income of up to a maximum of 90%. The proposed law in principle follows the modified nexus approach, but allows for more flexibility with regard to outsourced functions. The patent box in principle allows for Swiss and foreign patents to be covered as well as patent equivalent rights. Nonetheless, the referral to Swiss patent law indicates a very narrow patent box with limited application in areas of copyrighted software and embedded licences.
- Optional R&D super-deduction at the cantonal level up to a maximum of 150% of the effective qualifying expenses. The existing draft provides for a wide application of R&D activities that may benefit from support, including basic research and scientific application and knowledge-based R&D. The draft of the law proposes to apply the deduction on personal expenses (salaries and social security contributions) as well as an uplift of 35% to cover other R&D expenses. The qualifying amount is, however, limited to total effective R&D expenses. In addition to own expenses, expenses of up to 80% of related-contract R&D (including inter-company within Switzerland) are eligible for a notional deduction.
Switzerland intends to further establish itself as an innovation, finance and digital hub in order to preserve its competitiveness internationally. Consequently, this expense-side R&D tax relief is a crucial part of preserving this approach.
Lastly, it should be noted that a (notional) interest deduction on equity, the introduction of which is being discussed internationally (again) with the new name of an 'investment and growth promotion deduction', is highly disputed in Switzerland at present. Available information suggests that this instrument will not (yet) be included in STR 17. It is worth considering, however, that multinationals have a tendency to bundle international activities and that therefore not only the holding and R&D function, but also the mobile finance function will have to be attractive from a tax perspective in order to prevent other mobile functions that generally do not require much infrastructure from moving away.
In view of these facts, the introduction of this instrument is highly recommended – despite all of the criticism it is facing in Switzerland. This is especially true given the compelling prospects for the notional interest deduction from a tax systematic perspective. The Swiss Parliament could re-introduce a notional interest deduction in the final legislation, however given the continuing political discussion, it is more likely that a notional interest deduction could be part of a second legislative package to boost the attractiveness of Switzerland as a finance hub.
Tax systematic 'exit' from tax privileged regimes
The abolition of the tax privileges will be accompanied by a 'step-up' solution, which is already practised in various cantons in case of premature withdrawal from the privilege, based on the practice of the Swiss Federal Supreme Court. In the case of immigration to Switzerland, hidden reserves generated abroad, which are transferred to Switzerland, must be released in terms of the systematic of the tax regime in favour of the taxpayer, which is in deviation from the authoritative ('tax follows book') principle. In principle, STR 17 will cover the transition as follows:
- Step-up in the context of function relocation or immigrations from abroad with regard to hidden reserves, which are formed abroad and transferred to Switzerland at the time of the move – the step-up solution can also be based on the applicable law and the practice of the Swiss Supreme Court; and
- Special tax rate with respect to hidden reserves, which will be realised within five years following entry into ordinary taxation.
According to the view presented here, in the case of a transfer of functions to Switzerland, hidden reserves can already be released analogous to the exit taxation for emigration from Switzerland based on the applicable tax law and in terms of the systematic nature of the tax regime. Thus, a new legal basis is not required concerning this matter, but this interpretation is, as already stated and justified elsewhere in detail, in accordance with the international delineation principles and may be qualified as 'practice development' of Swiss law.
Other measures to be implemented
- Reduction of capital tax with respect to equity, which is attributable to shareholding, inter-company loans and to intellectual property rights;
- Adjustment of the NFA by taking into account, from a cantonal perspective, the mandatory fiscal measures to calculate the resource potential, and including a decreased tax income of legal entities compared to the tax income of individuals;
- Increase of the federal contribution to the cantons to provide financial support for the cantons during the implementation process of the reform.
Limitation of tax relief up to 70%
The limitation of tax relief up to 70% is a new kind of provision under the existing law of tax harmonisation which is not related to the determination of income in the strict sense of the term. In fact, it represents a 'bandwidth provision', which can be qualified either as a determination of income in the wide sense of the term or as a tariff provision, and thus – analogous to the structure of the tax rate – can take account of the individual financial strength of cantons and municipalities. Against this background, it is conceivable that cantons and municipalities will provide a different overall relief limit, which counters the critique during the vote campaign after which the situation of the municipalities was not sufficiently included.
Timeline for the implementation of STR 17
The Swiss federal government will introduce the final proposal of STR 17 by March 2018. The proposal is then to be discussed by the Swiss Parliament and passed in autumn of 2018. Assuming there will be no referendum/public vote, it can therefore be assumed that the new law will be implemented at federal level as of January 1 2019 and at cantonal level within a transition period of no more than two years – i.e. as of January 1 2021 at the latest. Discussions are under way to determine whether or not the federal law should be worded such that the cantons have to implement their law at the same time. In light of the inter-cantonal tax law, and for reasons of practicality, it would make sense for the mandatory federal provisions to be implemented by all cantons at the same time.
Partner, International Tax
Tel: +41 58 279 7290
Peter Brülisauer is tax partner at Deloitte in Switzerland. He has extensive experience in advising multinational companies on tax matters. This includes corporate restructuring, acquisition, finance restructuring, IP and R&D planning, cross-border tax planning, tax effective supply chain management, as well as function and risk allocation within multinational groups. He also specialises in permanent establishment (PE) planning and profit attribution between PEs.
Peter is lecturer in national and international taxation at the University of St. Gallen and a frequent speaker at tax conferences. He has a PhD in law from the University of St. Gallen and is a Swiss certified tax expert.
Manager, International Tax
Tel: +41 58 279 7279
Manuel Angehrn is a manager in the international business tax team at Deloitte in Switzerland with more than five years of experience in international corporate tax matters. He assists global companies and Swiss domiciled enterprises in tax structuring projects to prepare for the impact of changes in Swiss tax legislation as well as cross-border reorganisation of finance and IP functions. Manuel is a Swiss certified tax expert.